Farm Ireland

Wednesday 17 January 2018

'Do not use the new low-cost loans for struggling farms to mask underlying business problems'

Low-cost funds should not be used to disguise other fundamental profitability issues within the business.
Low-cost funds should not be used to disguise other fundamental profitability issues within the business.

Philip O'Connor

The downturn in farm profitability along with significant cash-flow issues across all farming sectors has been well highlighted in recent months.

The recent budget, through various means, tried to help with these problems. One area targeted by the budget was the access to low-cost funds for business.

While this is of huge benefit to the sector, it will only be valuable if used for the right reasons. Low-cost funds should not be used to disguise other fundamental profitability issues within the business.

One of the main pro-comments about the new loans is that they will replace other high-interest credit, for example merchant and/or bank. However, if a farm is struggling with making interest payments on capital loans or merchant credit, is a lower interest loan the long-term answer to the business cash-flow problems?

Will in fact more borrowings increase the cash-flow problems and effectively cover over more fundamental cash-flow/ profitability issues in the business?

While the loan is of massive benefit in the short term to the farm - a vital and necessary injection of cash - it could have long-term profitability issues for the business as the farmer may not be in a position to repay the money in the years to come.

If a business is in this situation it must look at its own cost base and earning potential as the business will need to raise additional funds to re-pay this loan.

Farmers must not ignore the most basic principles of borrowing money - it has to be paid back.

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All borrowings - short, medium and long-term - should therefore be viewed in the same manner; are the borrowed funds going to make a return on investments (ROI); are these funds going to make the business more profitable and therefore allow the business to repay the money (plus interest) along with making an additional contribution to the business profits?

If the answer is NO to these questions, should you be really borrowing the money or should you be targeting the borrowings at an investment that will make a greater return?

Ultimately when borrowing money it will come down to this simple fact - can you afford to make the monthly/yearly repayments? In bank circles they call this 'repayment capacity'.

While the ability to repay money might not be there every year (for example in 2009, 2013 and again 2016), it has to be there in the majority of years. Options like interest-only don't last forever; at some stage capital repayments must be made to the lender.

As stated above, access to low-cost credit is going to be of huge benefit to the farming sector, but only if used for the right reasons. If the underlying farm is profitable at a reasonable commodity price and the business is more than able to meet its financial commitments, then of course borrowing money is a plausible and correct solution in helping in the current cash-flow crises, either as additional working capital or replacing existing high merchant credit/bank loans.


However, equally if the farm has been running at a cash loss in recent years or needs a high commodity price/yields, is borrowing money regardless of rates the correct solution?

While in theory the farmer wishes to use the money to pay for other debt or as working capital, it in fact ends up been added to overall debt - for example, loan used to pay down merchants or an overdraft, but 12 to 18 months later, creditor and overdraft are again back to current levels.

These farms need to review their entire farms financial performance and fundamentally ask themselves - will they be better or worse of in one to three years plus time? Where will they be when the next milk/beef/grain price crash happens or the next weather crisis? What happens if it's in 2017?

Restructuring and increasing debt can have a huge positive effect on business both in terms of increased profits and available cash to a business. But only if the underlying business is profitable and able to meet its yearly financial obligations - your own personal drawings, revenue, bank repayments and possible capital investments.

Farmers need to continually review and be honest about their financials. Is the farm profitable? Can the farm meet its financial commitments? Is the farm reliant on unrealistic average prices to make it profitable?

Every business regardless of sector needs to be critical when analysing its own performance. If a farm isn't able to meet its financial commitments at a reasonable commodity price, what steps does the farmer need to make to bridge this gap?

The answers to these questions can't be simply to borrow more money and ignore all other aspects of the business.

Philip O'Connor is an agriculture support manager at Ifac Accountants in Cahir, Co Tipperary

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